Wednesday, May 22, 2013

Why American Business Should Support the Bona Fide Fiduciary Standard of Conduct for Investment Advice

American business is the engine which drives forth the
growth of our economy, and delivers prosperity for all. An important component
of the fuel for this engine is monetary capital. Yet, this monetary capital is
not efficiently delivered to the engine of business … it’s as if the engine is
stuck using an outdated, clogged carburetor, in the form of substantial intermediation costs by current investment banking practices.

More importantly, the transmission system of our economic
vehicle is failing, leading to far less progress in our path toward personal
and U.S. economic growth. The transmission system is large, heavy and unwieldy;
its sheer weight slows down our vehicle. It unnecessarily diverts much of the power
delivered by the engine to Wall Street, rather than deliver it to the investors
(our fellow Americans) who provide the monetary capital.

The ramifications of this inefficient vehicle are many, and they are severe. The cost of capital to business is much higher than it should be, due
to the significant intermediation costs of Wall Street in raising capital. And,
because Wall Street currently diverts away from investors 35% or more of the
profits generated by American publicly traded companies, often through high
fees and other hidden fees and costs, investors receive far less a proportion
of the returns of the capital markets.

This all leads to a high level of individual investor distrust in our system of
financial services and in our capital markets. In fact, many individual investors,
upset after discovering the high intermediation costs present, flee the capital
markets altogether. As a result, the capital markets are further deprived of
the capital which fuels American business and economic expansion, and the cost
of capital is again raised. Indeed, as higher levels of distrust of financial
services continue, the long-term viability of adequate capital formation is
threatened.

Even more severe are the long-term impacts of high
intermediation costs imposed by Wall Street firms on investors themselves.
Individual investors, now largely charged with saving and investing for their
own financial futures through 401(k) and other defined contribution retirement
plans and IRA accounts, reap far less a portion of the returns of the capital
markets than they should. These substantially lower returns from the capital invested, due to Wall Street’s
diversion of profits, result in lower reinvestment of the returns by individual investors; this in tern also leads to even lower levels of capital formation
for American business.

As individual Americans’ retirement security is not
adequately provided through their own investment portfolios, saddled with such
high intermediation costs, burdens will shift to governments – federal, state
and local – to provide for the essential needs of our senior citizens in future
years. These burdens will likely become extraordinary, resulting in far greater
government expenditures on social services than would otherwise be necessary.
As a consequence, higher tax rates become inevitable, for both American business and
individual citizens alike.

In essence, American business has become Wall Street’s
servant, rather than its master. The excessive rents extracted at multiple
levels by Wall Street firms fuels excessive bonuses paid, in large part, to
young investment bankers. Wall Street also drains some of the best talent away
from productive businesses, as well. Consequently, Wall Street has become a huge
drain on American business and the U.S. economy, as it derives excessive rents
at the expense of corporations and individuals. The financial services sector, rather than providing the grease for American's economic engine, instead has become a very thick sludge.

There is but one solution to this crisis. The compelling
answer to the problem presented by Wall Street’s excessive growth and
consumption of a 35% or greater share of the profits of American business lies
in the application of the bona fide fiduciary standard of conduct to all
providers of personalized investment advice. Simply put, this broad-based
fiduciary standard requires only that financial advisors act in the best
interests of their clients.

Yet, Wall Street strongly opposes efforts by the U.S.
Department of Labor (Employee Benefits Security Administration) and the U.S.
Securities and Exchange Commission to apply a bona fide fiduciary standard to
the delivery of investment advice to retirement plan sponsors (business
owners), retirement plan participants (employees), and to all Americans. Worse
yet, Wall Street and its proxies – brokerage firms, insurance companies, and securities
industry organizations which oppose the fiduciary standard – seek to have a “new
federal fiduciary standard” adopted which is not a true fiduciary standard at
all, and which would permit Wall Street to continue to extract excessive rents
from the U.S. economy.

By way of explanation, Wall Street will “accept” more
disclosures – provided, of course, they are as general as possible and, as to
details, only provided upon request of the client. Yet, a bona fide fiduciary
standard of conduct requires much more. While disclosure is important, under a
bona fide fiduciary standard of conduct conflicts of interest must be either
avoided or, if not avoided, properly managed. And the proper management of a
conflict of interest requires not just disclosure of the conflict, but also
affirmative disclosure of all of the ramifications of that conflict of interest
in a manner designed to ensure client understanding and to secure client
consent. Even then, the client must not be harmed (for no truly informed client
would ever consent to harm), and the transaction must be substantively fair to
the client. Wall Street resists these requirements with a passion, for it knows
it would be unable to extract excessive rents, as it does currently, if a bona
fide fiduciary standard is applied.

In summary, the bona fide fiduciary standard of conduct is
good for all Americans. More importantly, it is good for, and strongly needed
by, American business. The application of a true fiduciary standard will assist
to restore the much-needed trust in our capital markets, so necessary to foster
capital formation and resulting economic growth. Application of the fiduciary
standard will result in a much larger and more appropriate share of the returns
of the capital markets flowing – not to Wall Street – but instead to investors.

The fiduciary standard of conduct, if applied correctly,
will enhance the retirement security of our fellow Americans, reducing future
burdens on governments, leading to lower tax rates in future years and greater
prosperity for all.

The proper application of the fiduciary standard
to the delivery of investment advice, as is now being considered by the DOL and
SEC, provides an historic opportunity for American business to speak up, demand
adoption and implementation of the bona fide fiduciary standard. In this
manner, American business will foster its own future growth, and greater future
prosperity for business, our fellow Americans, and for America itself.

I call upon American business leaders to speak up, and let policymakers in Washington, D.C. and beyond know of their concerns for adequacy of future capital formation and economic growth. Unite to restore faith in our capital markets. Resolve to rid our economy of the sludge which slows it down so much, in favor of a more efficient engine and transmission which will propel American business to greater prosperity.

Ron A. Rhoades, JD, CFP(r) is an Asst. Prof. of Business at Alfred State College. To follow this blog, please follow him on Twitter (@140ltd) or link to him via LinkedIn. Please direct any questions to RhoadeRA@AlfredState.edu. Thank you.

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About the Author

Ron A. Rhoades, JD, CFP® sailed across the Atlantic on a tall ship, performed in theme parks and road shows in Europe and America as a Disney character, rowed on a championship crew team, marched in the Macy’s Thanksgiving Day Parade, marched in competition with a state-champion rifle drill team, undertook a solo one-week trip into the Everglades, escorted numerous celebrities around Central Florida, performed as a “Tin Man” at a mountaintop theme park called “The Land of Oz” in Beech Mountain, NC, and served as a stage manager and talent scheduling coordinator for entertainment productions at Walt Disney World. And then he graduated college.

Since then, Ron Rhoades earned his Juris Doctor degree, with honors, from the University of Florida College of Law, which was preceded by a B.S.B.A. from Florida Southern College. Ron Rhoades has 30 years of experience as an attorney, with nearly all of those years substantially devoted to estate planning, tax planning, and retirement plan distribution planning. Ron also has over 15 years as a personal financial adviser. He was a principal with an investment advisory firm where he served as its Director of Research and Chair of its Investment Committee.

The author of numerous articles published in financial industry publications and several books, Dr. Rhoades has been quoted in numerous consumer and trade publications, and has been interviewed on Bloomberg's "Masters in Business" radio show segment. He writes occasional articles for industry publications. Ron is a frequent speaker at local FPA chapter meetings and national conferences in the financial planning and investment advisory professions.

Ron Rhoades was the recipient of The Tamar Frankel Fiduciary of the Year Award for 2011, from The Committee for the Fiduciary Standard, as he “altered the course of the fiduciary discussion in Washington.” He was also named as one of the Top 25 Most Influential persons associated with the investment advisory profession in 2011 by Investment Advisor magazine, and was voted to the “Sweet 16 Most Influential” in Wealth Management’s 2013 “March Madness” competition. Dr. Rhoades was also named as one of the "Top 30 Most Influential" members in NAPFA's 30-year history in 2013. This blog was also called one of the "Top 25 Most Dangerous" in financial services.

Ron A. Rhoades, JD, CFP® became Program Director for the Financial Planning Program (B.S. Finance, Financial Planning Track) at Western Kentucky University's Gordon Ford School of Business in July 2015. He provides instruction to highly motivated, exceptional undergraduates students in such courses as Applied Investments, Retirement Planning, Estate Planning, and the Personal Financial Planning Capstone course. He has previously taught courses in Insurance & Risk Management, Employee Benefits, Money & Banking, Advanced Investments, and Business Law I and II.

Ron also serves on the Steering Committee of The Committee for the Fiduciary Standard, on whose behalf he frequently travels to Washington, D.C. to meet with policy makers in Congress and in government agencies regarding the application of the fiduciary standard to personalized investment advice.